At a Glance

  • Business intelligence tools can help materials managers and managers in the operating room and procedural areas track purchasing costs more precisely and determine the root causes of cost increases.
  • Data can be shared with physicians to increase their awareness of the cost of physician preference items.
  • Proper use of business intelligence goes beyond price benchmarking to manage price performance over time.

In the next 10 years, Medicare payments will be reduced by more than$150 billion, and Medicaid disproportionate share hospital payments will be cut by $14 billion. Without this revenue, hospitals will need to identify new cost savings opportunities or new sources of revenue to keep their doors open. This issue is especially important because many not-for-profit hospitals operate on margins as low as 1 to 3 percent. Some organizations are turning to their purchasing departments for answers.

Today’s hospital purchasing departments are investigating opportunities to rebid contracts midterm, switch to capitated pricing models, and increase standardization of products to better contain supply chain costs. However, hospitals often find that three common phenomena—product creep, price creep, and cost shifting—can cause their supply chain savings to fall short of expectations.

Product creep occurs with the unmonitored introduction of unauthorized, higher-priced products—frequently at list price—into the formulary or the shift toward higher utilization of higher-cost products, resulting in increased use of more expensive items.

Other critical watch points that purchasing should monitor are price creep and cost shifting. Price creep occurs when suppliers slowly increase prices over time or apply fixed discounts to new price lists. In contrast, cost shifting occurs when suppliers seek to compensate for discounts by quietly increasing prices. These increases may go unchecked by or be hidden from view of hospital purchasing departments until they analyze their spend history in aggregate retrospectively.

Often ignored or, again, simply hidden from view, both price creep and product creep have a major impact—especially on the cost of physician preference items, such as cardiac stents, cardiac rhythm devices, and orthopedic implants. These items often represent 40 percent of a hospital’s supply budget. And unless a concerted effort is made to uncover the issue, price creep and product creep will hurt an organization’s bottom line.

Things are further complicated with the practice of vendors working directly with physicians in the operating room while the purchasing department negotiates the contracts in another part of the hospital. This practice makes it difficult to track whether separately purchased physician preference items fall within agreed-upon contracts—and makes it easier for manufacturers to introduce new technology that falls outside pricing agreements. The result: an unexpected upcharge or price increase.

For example, a physician performing a total knee replacement on an active 45-year-old man may decide to deviate from the contractually agreed-upon construct to add a new-and-improved insert for an additional charge of $1,000. Clinically, this insert may be appropriate and worth some additional cost to benefit the patient in the long term. But the physician’s noncompliance with the purchasing agreement might be fiscally inappropriate if it results in a substantial upcharge—if, for example, most other hospitals are paying $600 for the same new component. If often repeated, this type of product creep could result in a significant budget upturn.

So how can hospitals work to prevent product creep, price creep, and cost shifting? Proactive hospital managers are using business intelligence to track purchasing costs more precisely and determine the root causes of cost increases, particularly in the operating room and catheterization lab.

Capitated Pricing: Part of a Cost Management Strategy

Capitated agreements are one means hospitals have employed to control costs, typically within the more complex product categories, where cost-reduction strategies are especially desirable.

In orthopedics, for example, hospitals negotiate with manufacturers to group orthopedic components into a construct at an aggregate price for common surgeries like hip or knee replacements. Even so, loopholes in capitated pricing structures can still allow price creep and product creep to enter, such as when additional components are substituted.

For example, manufacturers may introduce more expensive special or niche products that don’t fall into an agreed-upon construct, but that demonstrate a clinical benefit. Components that are not part of the agreed-upon construct may be replaced with a more expensive part, as with the knee replacement example. Manufacturers also may use cost shifting, reducing costs of certain contractually covered products to meet the capitation price, but charging inflated prices on additional components within the construct while still meeting the cap.

Aultman Hospital in Canton, Ohio—a member of Ohio’s Independent Hospital Network—spends $60 million annually on supplies. Every year, Aultman’s CEO asks staff to trim the budget by 5 percent, or $3 million to $4 million. The hospital uses spend-management and price-benchmarking business intelligence tools to achieve pricing normalization across vendors and manage its supply costs.

An example of product substitution illustrates the effectiveness of these tools. Aultman negotiated a capitation price for a total knee implant with four components. However, with the use of spend management analytics, Aultman’s purchasing department learned that additional components were being used that increased the cost of the implant by 30 percent. The hospital is rebidding the contract.

It’s also important to note that hospitals cannot simply rely on capitation or capitated pricing to address price increases. Why? Although hospitals may pay a predetermined amount for an item, they do not necessarily know whether they are purchasing the item at or below the market rate—only that the price won’t exceed a certain amount. Business intelligence solutions can provide price benchmarking data that offer insight into how the negotiated price compares with the market rate.

For example, FHN, an integrated delivery system (IDS) in Freeport, Ill., thought it had done a good job of standardizing products and negotiating better construct prices because of a market share agreement, but learned through its price benchmarking solution that it was paying $1,200 more for an implant than other IDSs its size. After drilling down a little deeper, FHN learned that one component within the construct was priced in the 90th percentile, meaning that 90 percent of hospitals were paying less for this component. Armed with this information, the hospital negotiated the price to the 50th percentile, saving $800 per case. This hospital performs approximately 300 of these procedures each year, so the resulting savings totaled about $100,000 per year.

The Need for Business Intelligence

Hospitals can better control their budgets using business intelligence solutions that provide insight into market share and prices other hospitals are paying for products. Business intelligence enables contracting personnel to review pricing in a particular category across the marketplace to identify price discrepancies. Without the ability to analyze their hospitals’ own spend data against national pricing data, hospital leaders are forced to rely on gut feelings, previous contract agreements, or the pricing information that vendors provide during the negotiation process in attempting to determine how the price of a product stacks up in the marketplace.

This intelligence not only is important when negotiating a new contract, but also plays an important role in identifying price creep and product creep in existing contracts, especially in product categories with dynamic pricing models, such as physician preference items.  Manufacturers are always innovating, with new, advanced technology items that are not in the existing contract (often referred to as carve-out items) and that are paid for under a different arrangement. Without a business intelligence solution to identify such carve-outs, hospitals often learn about the costs only after analyzing their aggregate spend retrospectively.

Like many hospitals across the country, Allina Health, an 11-hospital, 90-clinic IDS in Minneapolis, is undertaking an ongoing effort to produce $10 million in savings per year and uses business intelligence tools to help identify opportunities for cost reduction. Before Allina began using business intelligence tools, the IDS reviewed usage, physician cost variation, and its own price trends over time, but it was missing a critical piece of the puzzle: the ability to compare its product prices with pricing for products used by other, similarly sized IDSs.

Now, Allina uses benchmark analytics daily to forecast and set priorities for work, review contract spends, and identify opportunities for better pricing. Allina also relies on business intelligence to develop negotiation strategies and set project targets. For example, if Allina has a big spend and a big market share with a supplier in a product category, Allina expects very competitive pricing. If the supplier’s prices are higher than Allina’s leaders believe they should be, the IDS works toward negotiating a better price.

Aultman Hospital has been able to successfully use business intelligence to achieve supply savings. In just two years of using business intelligence analytics tools, Aultman has identified $300,000 in savings for cardiovascular devices, using price benchmarking data to negotiate better pricing. As a result, Aultman has been able to rapidly improve its cardiac pricing index from 38 to 33, saving $765,000.

Purchasing Can Improve Physician Alignment

Hospitals also are using business intelligence to align with physicians in containing costs for physician preference items. As the nation moves forward with healthcare reform and bundled payments, it will become more important to develop alignment and engagement strategies. Whether or not hospitals employ physicians groups, they need to find ways for physicians to advocate for their cost-savings initiatives or risk runaway costs on physician preference items.

By sharing cost and utilization data with both employed and independent physicians, hospitals can better advocate for physician support of initiatives that have the potential to reduce supply chain costs significantly without the risk of a negative impact on patient care.

To prepare for conversations with medical staff, hospitals can pull utilization data and drill down to usage by hospital, by procedure, and by surgeon to get the objective data needed to give physicians, nurses, and others a broader view than what they might have gained from their relationship with suppliers or experience with a particular product.

Steps for Reducing Costs

The best approach to a major cost reduction initiative is to focus first on products with the largest annual spend and then on services associated with significant expense. Keeping an eye on the price of high-volume items also will help reduce costs by decreasing the risk of price creep.

Hospitals also should consider taking the following six steps.

Engage with physicians to create a unified front. Hospitals can use business intelligence to educate their physicians about pricing, gain their perspective on why specific products are needed or work better than others, and engage them in the negotiating process with manufacturers. Although it may be easier to work with employed physicians, hospitals also should align with independent practices in this effort. This effort may require a little more creativity, such as looking at other departments’ capital budgets and new equipment requests or determining how to improve transitions in the operating room. When the negotiations conclude, hospitals should share any successes with the physicians.

Use business intelligence solutions to monitor purchasing. Hospitals can use analytics daily to understand the market more clearly and hold manufacturers accountable. It’s important for hospitals to conduct frequent checks to make sure they are not experiencing product or price creep. If a hospital learns that the market price for a product has dropped, the hospital can use this information to renegotiate its contract. By the same token, if a hospital finds an incidence of price creep, it may be eligible for a rebate. Business intelligence that connects spending with charge activity provides the visibility to ensure checks and balances in both areas.

Assess whether the hospital’s prices are in line with industry norm. Physicians often say that they know they have good pricing. The question is whether they are basing this assumption on something they have been told or on empirical data. Business intelligence that uses benchmark data for comparisons keeps everyone informed and pricing in check.

Tighten terms and conditions of contract boilerplates. Contracts should be modified to address new technology and new product releases to ensure capitation issues are addressed. Hospitals also should make sure that contracts do not include escalator, evergreen, or auto-renew clauses. The contracts should include terms and conditions that compensate the hospital when surgeons deviate from the construct or substitute a like product, so that the product price will remain the same.

Elevate the role of purchasing and supply chain leaders. These experts should be positioned to offer direct feedback to the hospital’s executive team, thereby fostering leadership support for cost-reduction measures.

Work with the group purchasing organization to review contracts against its contracted rates. Consideration also should be given to working with other area hospitals to create a purchasing coalition that allows the group of hospitals to aggregate volume and generate greater savings on commodity items.

An Intelligent Approach to Supply Cost Containment

Easy access to accelerated business intelligence is essential to proactively managing and leveraging vast amounts of data—and ultimately to surviving the current healthcare environment. Business intelligence that provides timely, informed, accurate, and intuitive insight is one key to optimizing supply chain performance and service-line revenue.

Ernest Bunata is senior director, advisory services, VHA, Inc., Irving, Texas.


Publication Date: Thursday, August 01, 2013

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